Author: David Olnick, Investment Executive
Monday morning’s release of the CPI data was generally in line with expectations albeit the year over year change came in very slightly higher but still managed to show an 0.01 decline to an annualized rate of 6.4%. That is still a long way from the FED’s stated target of 2.00%.
- Early reaction in equities has been erratic with stocks moving both higher and lower in volatile trading, however, as of this writing equities are breaking down. Bond yields, on the other hand, have been moving higher again and it is the rise in yields that is pushing stocks lower.
- Since November, the 2 year treasury yield has moved within a range of roughly 4.50% to 4.08%. Early February saw the recent low yield in 2 year treasuries as investor confidence was gaining that the FED was almost done with rate hikes. Reaction to the last 0.25% rate increase was positive in that yields fell on the announcement of the rate hike while stocks gained. However, that enthusiasm was quickly reversed 2 days later when the monthly employment report for January showed a much stronger gain in jobs than what had been expected. That put an end to the treasury rally and since then, yields have been rising again.
- At this point, the bond market is repricing itself back to 2 more ¼ point rate hikes which would take the Federal Funds rate to 5.00% – 5.25%. As a result, today we are seeing short-term treasury yields at 5.00% for the first time since 2006/2007 (see chart below). Currently it is the 6 month treasury that has pierced 5.00%, the 1 year T-Bill is not far behind however.
- 10 year treasury yields which had recently moved to near 3.40% are now back to 3.75%. Once again, short-term yields are rising faster than long-term yields resulting in another record inversion of the 2 year treasury yield versus the 10 yield treasury yield at negative 86 basis points thereby demonstrating a rising conviction that a recession is coming down the pipeline. There remains a lot of diverse opinion, however, as to how deep or shallow a recession might be.
- As it currently stands, I am not overly concerned that rates may be headed “meaningfully” higher. I am, however, more convinced that yields will remain elevated for longer since I see the path towards the 2.00% inflation target as taking much longer than many may be expecting. This should be good news for bond investors.
- For these reasons, I believe that bond investors can use any uptick in yields to add to positions. Especially those who are buyers of tax-exempt/municipal bonds, extending duration in order to lock in longer-term yields as yields move higher while, at the same time, maintaining short-term investments thereby employing a barbell type approach.
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